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Can VCs be Genuine? a.k.a. Can They Be Trusted?

by Bradley Miller on October 15, 2009

It’s been a little over a year since Sequoia’s infamous slide deck “leaked” to the internet proclaiming the end of the good times for start-ups.  The presentation contains tons of graphs detailing the oncoming downward spiral and suggested that start-ups tighten their belts in order to survive.  Clearly that was great advice, but my main issue with that message is that start-ups should be frugal to begin with and those who need a warning to cut back probably aren’t going to survive anyway.  Bill Gurley of Benchmark also issued a missive at the same time that listed about 10 do’s and don’ts for start-up survival.  Again, aren’t these things start-ups should do anyway to ensure survival?

I bring this up because at the time many commenters and columnists called out these warnings as disingenuous – the message conveyed by Sequoia and Benchmark was something VCs should tell their portfolio companies anyway, and by issuing such a warning (and highly publicizing it through an organized leak) they only served to create a panic.  A panic that tips the scale in their favor – the “harsher” the conditions, the more the risk, the lower the pre-money valuation for companies.  Sure, the economy was down, but VCs artificially raised the level of “economic harshness” through these missives, which actually benefitted them with lower pre-money valuations and thus larger chunks of companies. That or they’re madly brilliant – turning every day entrepreneur advice into a scare that benefits their portfolio.

That said, I think its good advice and good practice to remind companies to reevaluate their spending and burn rate – I object to the way it was done.  I think that Bijan Sabet, a partner at Spark said it nicely in a recent blog post: “we can all do better“.  What made me think of these notes from last year was Fred Wilson’s (of Union Square Ventures) post today that calls out VCs who say they need to command a specific percentage of a company.  He’s “calling bullshit” on VCs who make such comments.  And I believe him – it’s a disingenuous thing for a VC to do – to focus on a percentage rather than the true value they add to a company.  In a way, stating a desired percentage artificially deflates a company’s pre-money valuation, rather than focusing on what the company is really worth.  VCs, by only thinking in company percentages, are overreaching.  I applaud Fred for his message – as does Josh Kopelman of First Round Capital, who takes Fred’s VC greed point even further and says it’s a mistake for a VC’s required returns to drive company’s outcomes, rather than the other way around.  Again, I agree and am happy to see some VCs making this message.

But, on second thought, VCs are driven by returns – the largest return they can make to their LPs.  I think it’s a mistake to think this means “more altruistic” VCs will take a lower percentage of a company – afterall, they’re in it for the business, too. As an entrepreneur you have to take their points with a hint of caution. VCs are still out to get the most out of their companies, and part of that is taking as large of a percentage of a company as is possible.  A smart VC will balance the yin of the percent they take from the company with the yang of maintaining the founders incentive in making their company successful, but that often doesn’t happen.

It’s semi-noble Fred and Josh to express their vantage points, but it’s also smart business because they improve their image with founders.  I don’t have data, but it would be interesting to compare the average percentage of companies a VC takes versus the overall financial success of those companies.  Or, the macro performance of their funds.  Curious if some of my professor friends have insight on this?

Overall, I have to say thanks to Josh and Fred for making their posts, I think that the message is spot on, but I also feel that founders should take these statements with a gain of salt and always be aware of a VC’s true focus.

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